Challenges and Opportunities in DeFi: University of Zurich’s Taxonomy Report

Namaste Yogis. Welcome to the Blockchain & AI Forum, where your technology questions are answered! Here no question is too mundane. As a bonus, a proverb is also included. Today’s question was submitted by Liz from Paraguay, and she wants to know the latest university research findings on decentralized finance (DeFi).

Liz, you came to the right place. After receiving your question, it piqued my curiosity. Guess what? I found a treasure source of information! Before jumping into the findings, I’ll start by defining DeFi for new members to my blog.

Investopedia says, DeFi is an emerging financial technology, consisting of blockchains, software, and secure distributed ledgers, analogous to those used by crypto currencies. DeFI technology removes third parties and centralized institutions from financial transactions. DeFi challenges traditional finance by empowering individuals with the power to conduct peer-to-peer transactions. Now let’s discuss a research report produced by the University of Zurich, called “A Taxonomy for Decentralized Finance.”
https://www.zora.uzh.ch/id/eprint/254150/1/1_s2.0_S1057521924000152_main.pdf

Finding 1: Ethereum Reigns Supreme
Ethereum founders loved Bitcoin but noticed its limited utility. Their solution was to create Ethereum in 2014 as a second generation blockchain project that could be programmed to run on “smart contracts.” Smart contracts are code written into a blockchain that executes the actions two parties agree to outside the chain. By automating these actions, the need for an intermediary or trust between the parties is removed, and BOOM, you get the foundation upon which DeFi is constructed.

DeFi start-ups love Ethereum. In fact, 36% of all DeFi start-ups use Ethereum as their base layer technology. There are alternatives to Ethereum, including Solana, Cardano, etc. but no other layer one blockchain comes close to Ethereum for DeFi start-ups.

Finding 2: DeFi is Moving Towards Decentralized Governance
DeFi start-ups are built with the goal of eventually becoming decentralized in their governance. This is not surprising. After all, DeFi is constructed on the premise, perils, and promise of decentralization. Earlier this year, the Securities and Exchange Commission (SEC) approved Bitcoin and Ethereum ETFs. The SEC relented and finally recognized the decentralized nature of their governance. Other decentralized layer one blockchain projects may also receive SEC future approval relatively soon.

Finding 3: DeFi Systems Need Interoperability
Blockchain projects are monolingual. Essentially, blockchains don’t “communicate” well with each other. DeFi will not surpass traditional finance until interoperability becomes a DeFI reality.

Today, DeFi projects are essentially incapable of interacting with one another. Yes, there are “bridges” that connect blockchains. However, existing bridges are slow, weak, and incapable of sustaining a large-scale financial system. As Cardano founder Charles Hoskinson has said dozens of times, “… blockchains need to become as interoperable as Wi-Fi for mass adoption to take root.”

Finding 4: Regulatory Risk
DeFi pioneers are sailing unchartered regulatory waters. I’m not referring to fraud. Fraud is illegal regardless of technology and there are plenty of existing laws against fraud. I’m referring to the failure of Congress to pass DeFi legislation. The result? The SEC has stepped into this power vacuum and has deployed its enforcement authority to decide DeFi policy! Unelected bureaucrats are the bosses. What’s worse, SEC is a captured regulator. Captured by who? Captured by the industry it regulates and the incumbents are not too keen on opening the door to competition.

Let’s end with a proverb from Paraguay, where they are fond of saying: “… a lamb with a little mark will eventually leave the flock”.

Until next time,

Yogi Nelson